August 2019 - Sachse Construction

Is Cooling Ahead for the Hotel Market?

Citing changes in the depth and timing of an expected slowdown in the U.S. economy, CBRE hospitality experts are predicting a deceleration in demand for hotel guestrooms now through 2020 and have lowered forecasts for RevPAR. The good news is the outlook for 2021 has improved, according to the September edition of Hotel Horizons.

CBRE Hotels Research projects GDP growth to average 1.9 percent during the second half of 2019, or half the pace of the first half of the year. That change led CBRE to project hotel demand to grow by 1.4 percent for the rest of the year, compared to an increase of 2.1 percent for the first six months of 2019. CBRE is now forecasting the national occupancy level to decline by 20 basis points from 2018 to 2019.

Since changes in guestroom rates tend to lag occupancy changes, the annual increase in ADR will remain steady at 1.1 percent, Mark Woodworth, senior managing director of CBRE Hotels Research, said in a prepared statement. But the 2019 demand slowdown should begin to impact ADR in 2020 and so CBRE has lowered its ADR growth forecast to 2.0 percent. An increase in new hotel openings next year is also expected to add to the downward pressure on guestroom rates, Woodworth noted. The 2020 supply growth forecast is 2.1 percent, rather than the long-run average of 1.8 percent. The combination of factors should drive an 80 basis points national occupancy rate decline for 2020, he said.

CBRE has lowered RevPAR expectations to an increase of just 0.9 percent for 2019 and 1.2 percent for 2020. Both figures are lower than the June forecast.

2021 Numbers to Improve

Although noting the economic forecast for 2021 is still a bit anemic with 1.5 percent GDP growth and employment levels expected to decline by about 0.2 percent, CBRE did adjust the 2021 ADR and RevPAR numbers up a bit from its June report. The CBRE forecast now projects a 0.8 percent RevPAR gain, up from the 0.5 percent decline suggested in June.

The September report notes that while CBRE Economic Advisors do expect the U.S. economy to slow down over the next several years with GDP growth rates ranging from 1.5 percent to 2.3 percent through 2022, the team does not anticipate a full-fledged recession. With that in mind, CBRE is forecasting RevPAR to also have low levels of growth ranging from 0.8 percent to 1.9 percent.

Back to Basic on Construction Performance Payment Bonds

Are you in the contracting business and trying to understand the different bonds that you may need on a project? Many people do not realize that construction surety bonds have been around since ancient times, but that does not mean that everyone is familiar with how they work. Not to be confused with savings bonds your grandmother bought you when you were a kid, James Bond, or Barry Bonds, a construction bond is a type of surety bond used by public entities, owners, and prime contractors on construction projects. These types of bonds protect interested parties against disruptions or financial loss due to a contractor’s failure to complete a project or failure to meet contract obligations.

The Whats and Whos of Bonds

What and who are we dealing with when we talk about construction bonds? Bonds are contracts among at least three parties: (1) the principal, the primary party for whom the surety is guaranteeing will satisfy its contractual obligations; (2) the obligee, the party who is the recipient or beneficiary of the principal’s obligation and surety’s guarantee; and (3) the surety, the bonding company that assures or guarantees the obligee that the principal and surety will fulfill the principal’s contractual obligations. If the principal defaults on its obligations, i.e. does not do what they are supposed to do, a claimant can make a claim on the bond.Essentially, the claimant would be asking the surety to step in and perform or pay.

Performance and payment bonds are two of the most common bonds on construction projects. For federal projects over $100,000, performance and payment bonds are required by law. This is regulated by the Federal Miller Act, first enacted into law in 1935. Individual states have also looked to similar protections by enacting so-called ‘Little Miller Acts.’ Michigan’s Little Miller Act requires performance and payment bonds for any public contract exceeding $50,000 in value. Each bond is required to be a minimum 25% of the value of the contract with the contracting body having discretion to require higher values for the bonds and often requiring 100% of the value of the contract to keep it simple and avoid disputes over what is covered under the bonds. Many private construction projects, be they residential or commercial, may also have contractual provisions requiring contractors to get bonded.

A payment bond is typically acquired by the prime contractor as an assurance to the owner that all the prime contractor’s subcontractors and suppliers on the project will be paid for labor and material. The payment bond also serves as an added layer of protection to those subcontractors and suppliers seeking payment, as they are potential claimants on the payment bond if the prime contractor defaults on its payment obligations. Approximately 80% of claims are against payment bonds. A payment bond is a companion to the performance bond, so they’re most often issued together.

A performance bond guarantees to the obligee that the principal will perform its contractual obligations. If the contractor does not perform all aspects of the contract, the obligee – whether it is a public entity, owner, or prime contractor –may submit a claim against the performance bond. After a claim is made, the surety or bonding company issuing the performance bond may be required to complete the project in accordance with the contract or pay for the damages caused by the default.

The Whys of Bonds

Now that you know the what and who, you might be wondering, why are performance and payment bonds so prevalent in construction? Basically, they are another risk mitigation tool or an extra security blanket to make obligees or potential claimants feel safer that contractual obligations will be met one way or another. For principals providing the bonds, it satisfies your customer, but it is not a carte blanche to default knowing a bonding company is behind you; it is actually the opposite, and principals should do their best to avoid default and claims on their bonds. A bonding company typically requires the principal to sign an indemnity agreement before issuing the bonds, which means the principal will have to reimburse the bonding company for any claims the bonding company pays due to the principal’s default. Contrary to insurance companies, who expect a certain extent of losses from its insureds, bonding companies do not expect losses from their principals.

To help better understand, compare a performance and payment bond to a parent cosigning on their child’s auto loan. The parent has no expectation of paying that loan. The bank sees that the child’s credit is poor, because they’re a recent college graduate, so they want some protection by requiring a co-signor. The child has crunched the numbers, presented the sales pitch to their parent, and the parent trusts that their child, who has a full-time job, will be able to afford the payments and will be responsible enough to make the payments. If the child pays off the loan, everyone wins – the bank gets paid, the child enjoys continued use of the car and improves his or her reputation with the parent, and the parent is a proud supporter, who may get lucky enough to benefit from the child paying for their nursing home bills in the future.

If the child defaults on the loan, a lot of time and money is expended, and nobody wins. The bank will call the parent for the money; however, the parent is not going to automatically take the bank at their word and immediately pay off the loan. The parent is going to want to investigate and either push their child to take responsibility or see if the bank is even being fair in their demand. If the parent investigates and ultimately has to pay for the child, that child is probably going to have to pay the parent back – or do a lot of chores for a very long time. Lawsuits may ensue.

A bonding company that issues a performance and payment bond is like the parent in that scenario (but the bonding company receives immediate payment for their support).

Conditions of Payment

It’s important to stress that performance and payment bonds are not always an automatic guarantee of payment from the bonding company if a claimant decides to call on the bonding company to step in for the defaulting principal. It’s certainly not immediate. You might be thinking, what do you mean? I thought these are guarantees for performance and payment?

Before a bonding company will even start to investigate a claim, and long before it pays a claim, most performance and payment bonds have conditions precedent, i.e. rules, that a claimant must follow to get the bonding company’s attention. For example, a standard AIA performance bond form first requires notice to the principal and the bonding company that the obligee is considering declaring a default. Note that means the principal has not already defaulted or been declared to be in default. The bonding company wants formal written notice and an opportunity to avoid an outcome that requires paying a claim. If any rule is not followed, the bonding company may have basis to deny the claim entirely or in part. Therefore, it is important to read the language on the bonds carefully to understand the steps an obligee or claimant must follow before a bonding company will step up.

When the bonding company’s obligation arises, recognize that the bonding company’s liability is capped at the full face of the bond, i.e. the penal sum of the bond. Defaults can get very expensive and the penal sum may not be enough to cover full performance or payment. That is why it is always recommended that if there are any issues that could potentially give rise to a claim under a bond that the interested parties document everything and immediately reach out to thebonding company so that the parties can be proactive in resolving to mitigate everyone’s damages and avoid messy litigation.

In what may feel like an increasingly adversarial world, one might be reluctant to get sureties involved on an already crowded construction project. Performance and payment bonds can be a positive risk management tool, though, and should be used for the project’s success. The most successful construction projects require buy in and ultimate success from all the parties. Hopefully this article can be your tool to better understand any performance and payment bonds needed on your projects

Interest Rates Alter Global Real Estate Outlook

UBS Asset Management’s Real Estate & Private Markets, one of the largest asset managers of commercial real estate, just released its latest report. The study, which outlines how the change in the global economy has and will impact commercial real estate around the world, points to interest rates as the major player in the forecast.

As noted in the report, the global growth outlook has weakened as a result of trade hostilities, deteriorating business investment and political uncertainty. And with diminished growth expectations comes diminished demand for real estate. The main source of the altered forecast for real estate centers on interest rates. “The consensus expectation has gone in the last six months from one more Federal Reserve hike to the beginning of an easing cycle. At the same time, the [Bank of Japan, European Central Bank] and Swiss National Bank—they’re looking at how much deeper into negative territory they can go with interest rates,” Paul Guest, lead real estate strategist with UBS Asset Management, said in a video on the report. “All told, central banks seem to believe that preemptive easing is needed to keep growth on track.”

The change in interest rate expectations, he continued, means the risk premium is no longer decreasing and that translates into three possible outcomes for real estate investors, namely, more yield compression, particularly in higher-yielding secondary markets. Additionally, some investors will likely assume additional leverage as a result of low borrowing costs. Finally, in pursuit of higher yield, there could be an uptick in investment activity in such niche sectors as student housing and senior care facilities.

The one common theme among these potential outcomes is the assumption of additional risk. With the risk premia ceasing to narrow, UBS-AM has changed its two- to three-year forecast, going from a prediction of modest capital value erosion to one of flat or positive capital value growth, spurred by downward adjustments in interest rates. UBS-AM’s summary of the real estate market outlook: easing, on the one hand, uncertainty, on the other.

Regional Roundup

Looking at the current status of real estate in the Asia-Pacific, UBS-AM found that the industrial sector continued to lead the real estate market in terms of performance in the second quarter of 2019. The office market remained tight, but sentiment went on the downswing. As for APAC retail, low vacancies continued to bolster high rents. UBS-AM’s view on the retail sector was unchanged, with the firm remaining keen on prime retail, tourism-centric high street retail and dominant suburban or regional retail centers.

In Europe, demand remains strong in office and industrial, and supply is largely still constrained. And while investment volume is on the downswing, prices continue to hover at historically high levels. Retail, however, is another story. European retail, but for a few exceptions, is generally plagued with low demand and structural oversupply. Still, prime retail rents were a bit of a mixed bag in the second quarter, holding steady year over year in most major U.K. cities, but decreasing in Brussels, Amsterdam and Barcelona—and increasing in Milan and Naples.

In the U.S. commercial real estate’s status as a solid investment persists; the industry yielded steady returns consistent with long-term expectations in the second quarter. However, there were certain shifts in the sectors. Industrial demand remains high and net rent growth is still robust, but the pace of completions is still elevated, which increases risk in the forecast. In the office sector, returns remained strong in the second quarter, but capital expenditure requirements rose, producing lower cash yields.

In the retail sector, capital requirements increased as a result of the growing emphasis on mixed-use properties. Performance is expected to vary with the ongoing move away from apparel-based formats. Across the sectors, the long expansion—121 consecutive months of expansion, a record not seen in the U.S. since 1854, as noted in the report—is resulting in an increase in capital investment into stabilized assets. UBS-AM cautions investors to keep a sharp eye on the risk-return expectations for incremental capital.

Construction Firms Expect Labor Shortages to Worsen Over the Next Year

You’d have to be living on the moon not to know that hourly construction workers are getting scarcer. But the magnitude of this labor shortage is writ large in a recent survey, released this week by Autodesk and the Associated General Contractors of America (AGC), which found that 80% of 1,935 respondents in 23 states report having a hard time filling hourly craft positions.

More concerning are the findings that nearly three-quarters of the construction firms polled don’t expect shortages to abate over the next year, and could, in fact, get worse. And the training and skill level of the labor that is available are deemed “poor” by 45% of those polled.

It remains to be seen whether and how soon the industry can dig itself out of this hole. To attract workers, two-thirds of the survey’s respondents say they’ve boosted base pay rates, and 29% are offering incentives and bonuses. A longer-term play finds nearly half of the firms polled—46%—having launched or expanded their training programs. Half of the respondents also say their companies are involved in career-building programs.

The labor shortage is shoving a perennially tech-phobic construction industry into the 21st Century. One-quarter of respondents are using tools like drones, 3D printers, and robots. Another 23% are relying on lean construction techniques, BIM, and prefabrication.

The disruption being caused by labor shortages is also manifesting itself in costlier projects that take longer to complete. Forty-four percent of the firms polled are increasing their construction prices, and 29% are factoring longer lead times into their bids.

“Workforce shortages remain one of the most significant threats to the construction industry,” said Stephen E. Sandherr, AGC’s chief executive officer. “However, construction labor shortages are a challenge that can be fixed, and this association will continue to do everything in its power to make sure that happens.”

Over the past two years, AGC has secured $145 million in federal funding for career and technical education programs. It is urging the federal government to increase that funding, and to allow construction students to qualify for federal Pell Grants, which would make it easier for firms to establish apprenticeship programs.

More quixotic—given the Trump Administration’s virulent anti-immigration stance—is AGC’s call for the government to let more immigrants into the U.S. to work construction.

On Solid Ground

Stakeholders across the seniors housing sector have been keeping a careful eye on the robust construction pipeline that has been bringing new supply and increased competition to many metros across the country. Yet results from the sixth annual NREI/NIC seniors housing survey show a positive outlook over the coming year for sector performance and access to capital, along with predictions for a steady pace of transaction activity.  A majority of respondents in the latest piece in the NREI Research Series believe the sector will continue to perform well with both occupancy and rent growth in the coming year.

In all, 72 percent anticipate an increase in occupancies over the next year versus 65 percent who held that view in the 2018 survey, and an even higher volume, 78 percent, expect rents to rise in the coming year. Although that optimism is surprising, it may be a reflection that respondents are also more likely to believe that construction starts will decrease over the next 12 months, notes Beth Burnham Mace, chief economist and director of outreach at the National Investment Center for Seniors Housing & Care (NIC). Nearly one-third of respondents (32 percent) are predicting a decrease in construction starts over the next 12 months, which is up from 24 percent in the 2018 survey. Meanwhile, 45 percent of respondents expect to see an increase in seniors housing starts and 23 percent anticipate no change. “There is still some concern about construction, but it is a little bit less than we have seen in the past,” says Mace. Another factor contributing to sector optimism is that a majority of respondents (76 percent) do not think construction activity will result in overbuilding.

Views of slowing construction starts are consistent with NIC data, which does show signs of slowing. Construction starts during the second quarter amounted to 3.0 percent of total existing seniors housing inventory, which is down from 4.3 percent a year ago. “Especially for assisted living [AL], there is a clear downward trend in starts activity,” says Mace. As of second quarter, construction starts on AL properties amounted to 3.5 percent of total existing inventory, which is down compared to 6.5 percent in late 2015. “So, that is a pretty significant slowdown and that’s what respondents in the survey may be starting to notice,” says Mace.

Construction has been creating a buzz in the industry as both investors and lenders evaluate the implications for occupancy levels. Over the past five years, respondents have said that new and competing facilities have had the biggest impact on occupancy rates, and results of the 2019 survey are consistent with that trend. On a scale of one to five, with five being the most significant impact, 63 percent of respondents rated the impact of new and competing facilities as either a five or a four. However, that percentage is down compared to 69 percent a year ago. Again, that data suggests that there is still concern about construction, even though concern is a bit less than what past surveys have shown.

“The construction pipeline has definitely slowed, but there is still a fair amount of supply to absorb in certain markets. And as long as capital is flowing into the sector, developers will continue to build,” says Bill Glascott, chief investment officer with Green Courte Partners, a Chicago-based private equity investment firm. People are paying attention to that new supply, and capital is being more selective on which projects get funded. In addition, rising construction costs and wages are putting pressure on developer margins, which dampens that activity as well, he adds.

Stakeholders across the seniors housing sector have been keeping a careful eye on the robust construction pipeline that has been bringing new supply and increased competition to many metros across the country. Yet results from the sixth annual NREI/NIC seniors housing survey show a positive outlook over the coming year for sector performance and access to capital, along with predictions for a steady pace of transaction activity.  A majority of respondents in the latest piece in the NREI Research Series believe the sector will continue to perform well with both occupancy and rent growth in the coming year.

Respondents also rated the state of the U.S. economy as a very or somewhat significant factor at 43 percent; and state of the U.S. housing market at 39 percent. Rental discounts and concessions were viewed as having the lowest impact on occupancies at 34 percent.

New players continue to enter

The common theme in the seniors housing sector in recent years has been more and more capital flowing to the sector on both the equity and debt side. “Over the last five years there has been an increasing level of interest in the seniors housing space, and in the last year alone we have continued to see new entrants,” says Charles Bissell, managing director, seniors housing capital markets, at JLL. Those new players run the gamut from foreign capital and new private equity funds to non-listed REITs and other institutional capital sources. In fact, the market is seeing some of the largest funds ever raised that are dedicated to seniors housing, he adds. For example, PGIM Real Estate’s latest seniors housing fund, Senior Housing Partnership Fund VI, has a target capital raise of $750 million.

Respondents continue to view seniors housing as the most attractive property type compared to other sectors. When asked to rate the attractiveness of different property sectors on a scale of 1 to 10, seniors housing scored a 7.2, putting it ahead of apartments at 6.9 and industrial at 6.8. The respondent base could be skewing results a bit in favor of seniors housing. However, other surveys have found similar trends. For example, the ULI Emerging Trends for 2019 found that seniors housing ranked second among commercial real estate types for the best investment property sector and third in terms of best development prospects.

Factors that continue to fuel investor interest are a strong performance and a big demographic tailwind for demand powered by the aging population. According to the NCREIF index, stabilized seniors housing properties are consistently outperforming both apartments and the total NCREIF Property Index. The five-year annualized return for seniors housing is 13.1 percent compared to 8.2 percent for apartments and 9.1 percent for the total NPI. Investors also like seniors housing because it is viewed as somewhat of a recession-proof, needs-based product.

PGIM Real Estate has been an active investor in seniors housing since the late 1990s and has had a front row seat to the continued evolution of the market that has attracted more institutional investors. “Some of the capital coming into the industry is really good, because it creates liquidity, but it also does increase competition overall,” says Steve Blazejewski, managing director, seniors housing, at PGIM Real Estate. That being said, there are still some really good opportunities for acquisition and development, he adds.

Investor interest is generating an active pipeline for sales transactions. According to research firm Real Capital Analytics, preliminary second quarter data shows a rolling 12-month volume of seniors housing property sales of $15.8 billion, which is up 1.8 percent year-over-year. More than half of respondents (55 percent) think investment sales will remain the same over the next year, while 34 percent expect sales to increase and 11 percent predict a decline.

Mixed views on cap rates

According to Real Capital Analytics, cap rates for seniors housing and care assets have been moving higher since hitting a low of 6.8 percent in the fourth quarter of 2017. Preliminary second quarter data shows that cap rates rose 141 basis points to average 7.7 percent.

Respondent views are split on expectations for cap rates in the coming 12 months, although more are inclined to believe cap rates will move higher. In all, 43 percent said cap rates will increase; 34 percent think there will be no change and 23 percent anticipate a decrease. Sentiment is more divided compared to a year ago, when 58 percent of respondents were predicting an increase in cap rates. If cap rates do move, the general consensus is that any movement – either to the positive or negative – will be slight, with a mean change over the next 12 months of 9.1 basis points.

Although cap rates have been somewhat flat over the past three to five years, there is more pricing disparity creeping in, notes Blazejewski. “We are seeing the market absolutely reward newer assets, and particularly the top quality operators,” he says. “Conversely, we are seeing the market punish older assets and those that are vulnerable to new supply and competition.” For example, class-A assets with a best-in-class developer or operator are selling for cap rates in the low 5-percent range. At the other side of the spectrum, older assets are trading for cap rates ranging from 6 to 7 percent, he adds.

“Since we bought our first property in 2015, we’ve observed cap rate compression in conjunction with an increased appetite for independent living assets,” says Glascott. Green Courte Partners is currently investing its fourth fund, Green Courte Real Estate Partners IV, which has about $500 million of committed equity capital. Low-acuity seniors housing is one of three active strategies for the fund, and so far, accounts for nearly half of the capital deployed on behalf of the fund. “We’ve been more active in value-add deals, where we believe we can buy at a discount to replacement cost and price rents competitively, while giving us a basis that is somewhat defensive to planned or potential new supply in a given market,” says Glascott.

A majority of survey respondents predict that the time to close on transactions will remain the same at 69 percent, while 19 percent think deals could be slower and 12 percent believe closings could move faster in the coming year.

“In some cases, there is a bit of a gap between the seller’s desired pricing and what buyers are willing to pay,” adds Bissell. That mostly relates to assets that are not fully stabilized, he says. However, even with that gap there is a robust pipeline of deals. JLL’s seniors housing team, combined with its recent acquisition of HFF, currently has more than $3 billion in seniors housing properties that are either being marketing, under contract or in the pre-closing process.

Respondents bet on lower rates ahead

One of the biggest moves in the 2019 survey relates to expectations for interest rates. Only 25 percent of respondents believe rates will rise in the coming year, which is a dramatic drop compared to 84 percent who thought rates would move higher in the 2018 survey. Of course, in that time, the Fed did raise rates. But most recently, the Fed reversed course and reduced its target rate by 25 basis points. “I think that reflects that respondents are paying attention to what’s going on at the Fed,” says Mace.

When asked to what extent each of the following are a source of debt capital for seniors housing on a scale of 1 to 10, national banks and institutions rated the highest with a mean score of 6.5. However, local banks, the GSEs and REITs all scored high with scores above 6.0.

Construction and balance sheet financing are widely available, and Fannie Mae, Freddie Mac and HUD continue to provide strong financing for long-term, non-recourse permanent loans, notes Neal Raburn, a managing director on the seniors housing finance team at Greystone.  “Most of our capital partners have an increasing appetite for seniors housing year-over-year,” he says. In addition, just as there have been more players entering the sector on the equity side, there have also been new entrants on the debt side over the past few years. In particular, there have been more banks and also more debt funds that have become active in seniors housing, adds Raburn.

Overall, most respondents expect the lending environment for seniors housing to remain the same over the next 12 months. Half of respondents (52 percent) think underwriting standards will likely remain the same in the coming year, while 39 percent said underwriting could tighten and 9 percent believe underwriting could loosen. “Each transaction is different, but underwriting metrics really have not changed,” notes Raburn. Some exceptions occur when fundamentals related to the property or the market might warrant a more conservative approach, he adds.

Additionally, 61 percent predict no change in loan-to-value (LTV) ratios and 60 percent expect that there will be no change in the debt service coverage ratio. Although the survey response does show a bit of a disconnect on the outlook for the risk premium given views that interest rates could lower, 59 percent said there would be no change in the risk premium (i.e. the spread between the 10-year Treasury and seniors housing cap rates).

Investors favor high-barrier markets

Survey results indicate that respondents’ attitudes towards buying, holding or selling in the sector remain consistent. In all, 31.2 percent said they plan to buy assets over the next 12 months, while 54.8 percent said they plan to hold. Only 14.0 percent are looking to sell. That percentage looking to buy compares to 30.6 percent in the 2018 survey and 46.7 percent in the 2017 survey.

Those numbers could reflect some caution due to increased competition and pricing, as well as concerns about oversupply in some markets. “We are certainly seeing some overbuilding in certain markets. That can’t really be denied,” says Mace. For example, San Antonio at one point in the cycle had 21.6 percent of its inventory under construction. Although occupancies in that market improved to 82.9 percent in the second quarter, that level is still below the national average, which shows it is still catching up to that new supply.

When asked to rate the strength of market fundamentals by region on a scale of 1 to 10, the West/Mountain/Pacific rated the highest at 7.1; followed by the South/Southeast/Southwest at 6.9; East at 6.5; and Midwest /East and West North Central at 6.0. Results show a slight rise in sentiment for the West, up from 7.0 last year, while sentiment declined for the South from 7.2.

That might reflect that the South and Southeast have lower barriers to entry and easier entitlement processes and less regulation, making it easier to build a property, whereas the West tends to have more barriers to entry, limiting new competition, notes Mace.

“Everybody is focused on high barrier to entry markets. That seems to be the buzz word of the day,” adds Blazejewski. Part of that focus is due to the active construction market, as well as a broader trend among baby boomers who want to live in urban, walkable neighborhoods. “A lot of the same trends you see in apartments are now creeping into seniors housing,” he says. Infill projects also tend to be larger and more expensive, which is attracting institutional capital that is looking for scale.

Investors are also more cautious of markets that have experienced a spike in construction and increased competition, notes Bissell. Generally, investors like coastal markets and larger cities, while properties in the middle of the country tend to have the softest demand. The product types that are in most demand are those that offer a continuum of care for independent, assisted living and memory care, with demand that is especially high for West and East coast markets, he says.

Positive outlook on key metrics

Investors are keeping an eye on near-term challenges to the sector, which include rising labor costs that are impacting operating efficiencies. Although respondents are bullish on occupancy and rent growth in the coming 12 months, optimism is somewhat tempered by the fact that those increases will likely be modest. Seventy-eight percent of respondents believe rents will rise, with a mean increase that is slightly less than 1.0 percent. In addition, even though 72 percent of respondents believe occupancies will improve, the mean increase is slight at 21.9 basis points.

The latest NIC data shows that seniors housing occupancy rates in the U.S. have remained relatively stable, declining 10 basis points year-over-year to 87.8 percent in the second quarter. However, this does represent the lowest occupancy level since the second quarter of 2011. Occupancy rates for independent living and assisted living properties averaged 90.2 percent and 85.1 percent, respectively, during the second quarter of 2019.

NIC data also shows a greater disparity in fundamentals across local markets. Among the 31 metropolitan markets that comprise NIC’s Primary Markets, there is a 14.6 percent spread between the markets with the highest and lowest occupancies. San Jose, Calif. is reporting the highest occupancy at 95.7 percent and Houston is reporting the lowest occupancy at 81.1 percent. The variance is due to local market conditions that include economies, barriers to entry and new construction.

“Overall, respondents are definitely still very positive about the sector,” says Mace. “They see a less active construction market and generally improving occupancy rates and rental growth in an interest rate environment that would support continued borrowing and continued development.”

LEED residential market up 19% since 2017

The U.S. Green Building Council says that the LEED residential market has grown 19% since 2017.

Nearly 500,000 single family, multifamily, and affordable housing units have been certified globally, and more than 400,000 units are located in the U.S. On average, LEED-certified homes use 20% to 30% less energy than a traditional home, with some homeowners reporting up to 60% savings, according to a USGBC news release.

The USGBC report, LEED in Motion: Residential, lists the top 10 states for LEED certified homes in the U.S., with California coming in first. California has nearly 40,000 certified residential units, followed by Texas with more than 24,500.

Certified homes also save on water usage and are designed to support human health and comfort. LEED encourages designs that maximize indoor fresh air and use materials that help reduce exposure to toxins and pollutants connected to asthma, allergies, and other respiratory ailments.

Varnum Law Opens Birmingham Office as Part of Metro Detroit Expansion

Varnum LLP has opened a new office in Birmingham as part of a plan to expand its Southeast Michigan presence as large as its base in West Michigan.

The firm, headquartered in Grand Rapids, last week opened an 8,000-square-foot office off Brown Street in the city’s central business district, said Ron DeWaard, chair of the law firm. Eight attorneys moved there from its Detroit and Novi locations, and DeWaard plans to fill it out with seven more new attorneys in the next year.

The firm is tapping into the region’s large automotive supplier base for growth and sees potential new business in autonomous vehicles.

“There’s so many regulatory issues and emerging legal issues in terms of technology, data and privacy issues,” DeWaard said of the industry. “That kind of specialty area gives us capabilities that I don’t know any other firms can claim to have.”

In a generally stagnant legal industry, local law firms are facing stiff competition, with many diversifying their areas of practice to generate more revenue. Honigman LLP formed in 2017 a team of attorneys to focus on the autonomous vehicle industry. Other firms such as Dickinson Wright and Dykema have similar units.

Varnum entered the metro Detroit market in 2005 with an office in Novi and opened one in Detroit about 10 years later. Most of the firm’s 50 lawyers in Southeast Michigan, which also includes an office in Ann Arbor, were hired in the past five years — 15 in the past two years, DeWaard said.

In total, Varnum has 189 lawyers across eight offices in the state. In the next couple of months, it will move its Ann Arbor location to a Main Street office downtown that is twice the size. DeWaard said he plans to expand that office from six to 12 attorneys in the next year.

“What’s driving it is we’re able to take market share from other firms by developing a client-centric culture,” DeWaard said.

By number of attorneys, Varnum ranked 21st on Crain’s 2019 list of largest law firms in Southeast Michigan. It ranked as the second-largest law firm for number of attorneys in Greater Michigan, behind just Warner Norcross + Judd LLP.

Most of Varnum’s business comes from auto suppliers, including 22 tier-one suppliers, nine of which are among the 100 largest globally, DeWaard said. He declined to offer names, citing confidentiality agreements. Another large area of focus is estate planning.

The Birmingham office, led by senior attorney Mike Romaya, will build off a “significant client base” there and focus on estate planning, finance, litigation, labor and employment, trusts and corporate services. Detroit-based Sachse Construction served as construction manager for build-out.

DeWaard said there’s been talk of expanding the firm outside the state — to the greater Midwest and Florida — but the immediate goal is to build up its Southeast Michigan presence.

“We are ready, willing and able to expand the offices we have to accommodate growth, and we think right now, we are in the right locations.”

The Open Office Concept Is Beginning to Show its Limitations

More than anything else, office tenants want to attract and retain the right talent and are willing to pay a rent premium for office space attractive to younger workers.

The open office concept has been touted as the answer, with claims that it provides collaborative, amenity-rich workspaces that young workers prefer. But studies indicate that open office space:

  • Reduces face-to-face interactions, productivity and work quality;
  • Causes workers to wear noise-cancelling earphones;
  • Induces high stress levels and high blood pressure; and
  • Increases sick days and employee turnover.

“The best companies are not moving completely to open space, but are customizing offices with a mix of spaces, creating a hybrid solution that fits individual work styles and company culture,” says Christian Beaudoin, managing director of research and strategy with real estate services firm JLL.

Open office space reduces square footage required per employee compared to traditional office space. According to real estate services firm Cushman & Wakefield, on a national level, the amount of office space allotted each employee declined by an average of 8.3 percent between 2007 and 2017, to 193.8 sq. ft. To make up for lost personal space, office tenants and landlords are investing significant capital in tenant improvements (TIs) to create a variety of workspace options and shared amenities important to young professionals, including fitness facilities and health spas.

Part of this may be due to the specific issues created by open office space environments. According to a CBRE report “Top 6 Challenges and Solutions for a New Office Fit Out,” these offices tend to lead to higher ambient noise levels, higher vibration from the slab within the buildings’ steel frame structures (because of the absence of wall partitions and suspended ceilings), heating and cooling issues as occupants in large open spaces have different temperature comfort levels, and higher construction costs because the minimalist open floor office aesthetic can actually require more labor and high-quality materials to build out. Building owners then have to spend time and money to deal with these and other drawbacks.

Office TIs allowances jumped by more than 10 percent in 2017, by 13 percent in 2018 and are expected to increase by 12 percent in 2019 over the previous year, with the average U.S. office build-out costing more than $196 per sq. ft., according to JLL’s U.S. and Canada Fit Out Guide.

Beaudoin notes that tenants and landlords are sharing the cost of build-outs, with the length of the lease term correlating with the share of TIs the landlord is willing to provide.

Beaudoin also notes a trend of employers “treating adults like adults” by offering workers the flexibility to work when and wherever it is appropriate for their individual work style and type of work performed, including working from home or other locations off-site. But even employers with robust mobility programs usually require some office time, according to Coldoff.